Smart gifting strategies for inheritance tax planning

The end of the year often inspires us to think about generosity, whether it’s giving to loved ones or supporting causes close to our hearts. However, did you know that giving can also come with some pretty significant tax benefits? With a little planning, you may be able to make your gifts work harder for you.

Understanding gifting rules

In the UK, there’s no specific ‘gift tax’ per se. However, that doesn’t mean gifts are entirely tax free. Rather, the rules around inheritance tax (IHT) may come into play.

Most gifts you make during your lifetime to individuals are treated as Potentially Exempt Transfers (PETs). If you survive for seven years after making a PET, the gift is usually fully exempt from IHT. However, if you pass away within seven years, the value of the gift may be added back into your estate when calculating IHT.[1]

It is also important to remember that for a gift to qualify as a PET, you cannot retain any benefit from it. For example, if you gift a property but continue to live there rent free, HMRC may treat it as if you never gave it away.

Owing to these rules, gifting can be a powerful way to reduce the value of your estate over time, but it needs to be planned carefully. A financial adviser can help ensure that your gifting strategy is both effective and tax efficient.

If death occurs between three and seven years after the gift, taper relief can reduce the rate of IHT that applies, although it does not reduce the value of the gift itself.

Annual exemption

If you’re looking to give without worrying about IHT, the £3,000 annual gift exemption is a suitable option. Each tax year you, as the donor/transferer, can give away up to £3,000 in total, either to one person or split between several people, and these gifts are immediately outside your estate for IHT purposes.[2]

If you do not use the full £3,000 exemption in one tax year, you can carry it forward for one further tax year only, meaning you could gift up to £6,000 the following year. However, you must use the current year’s exemption first before applying the carried-forward amount.

Gifts out of excess income

Gifting from excess income allows you to make gifts from your income (not capital) without them being subject to IHT, provided they don’t reduce your standard of living.[3]

To qualify, the gifts must:

• Come from income such as salary, pension, or rental income (not from savings or investments)
• Form part of a regular pattern of giving or demonstrate an intention to be regular
• Leave you with enough income to maintain your normal lifestyle

Keeping detailed records is vital to prove that the gifts meet these conditions. HMRC will expect to see clear evidence, so working with a financial adviser can be very helpful to ensure everything is structured correctly.

Gifting for special purposes

There are a few other gifting options available (that are also free of inheritance tax):

• Gifts for weddings or civil partnerships: You can gift up to £5,000 to your child, £2,500 to a grandchild, or £1,000 to anyone else for weddings or civil partnerships.
• Small gifts exemption: You can gift up to £250 per person to as many individuals as you like. However, you can’t combine this with the £3,000 annual exemption for the same recipient.

Using trusts for tax-efficient gifting

A trust can be a good option if you want to gift assets while maintaining control. This means you can decide how and when beneficiaries receive their inheritance.

A trust involves transferring assets to a trustee/s, who manages them on behalf of beneficiaries. There are two types of trusts to consider[4]:

• Bare trusts: The beneficiary has an immediate and absolute right to the assets, which they can access at age 18 (16 in Scotland). For IHT purposes, gifts into bare trusts are treated like outright gifts and will usually fall outside your estate if you survive seven years.
• Discretionary trusts: As per the trust deed, trustees decide who benefits, when, and how. Gifts into these trusts are treated as chargeable lifetime transfers and may be subject to an immediate 20% IHT charge if they exceed the nil-rate band of £325,000. Discretionary trusts are also subject to 10 year periodic charges and exit charges (you can read more about them here: What are the benefits of discretionary trusts? : And should I use one? | Saltus).

While trusts can be valuable for estate planning, they involve complex tax rules. Professional advice is encouraged to ensure the trust is structured correctly and to manage potential IHT charges over time.

Gifting shares or investments

Gifting shares can be a useful way to reduce the size of your taxable estate for inheritance tax purposes. If you survive seven years after making the gift, the value of the shares will usually fall outside your estate. In some cases, shares that qualify for Business Relief can benefit from further IHT savings.

However, gifting shares to anyone other than your spouse or civil partner is treated as a disposal at market value for Capital Gains Tax (CGT) purposes. This means you may need to pay CGT at the time of the gift if the shares have increased in value. The recipient’s CGT base cost will be the market value at the date of the gift.

Gifting between spouses or civil partners is generally exempt from both CGT and IHT, making it a tax-efficient way to transfer investments within a marriage or civil partnership.

However, gifting shares involves complex tax rules, particularly around CGT, it is important to seek professional advice to ensure you gift in the most tax-efficient way.

Charitable giving

Charitable giving not only supports causes close to your heart, but it can also provide valuable tax benefits.

Under the Gift Aid scheme, if you are a UK taxpayer, charities can claim an extra 25% on top of your donation from HMRC at no extra cost to you. Additionally, if you are a higher- or additional-rate taxpayer, you can claim back further tax relief via your self-assessment tax return. For example, a £100 donation could be worth £125 to the charity, while you could personally reclaim up to £25 (or £31.25 if you pay the additional rate). You can find out more in our article: A guide to Gift Aid : What is it and how might it benefit you? | Saltus

Gifts to registered charities in your will are also completely exempt from IHT. If you leave at least 10% of your net estate to charity, the IHT rate on the rest of your estate may reduce from 40% to 36%. This can make donations a positive way to reduce your estate’s value.[5]

Another option to consider is donor-advised funds (DAFs). These allow you to make a contribution, receive immediate tax relief, and then recommend grants to your chosen charities over time, providing both flexibility and control in your giving strategy.[6]

Gifting property and real estate

Gifting property, whether it is your family home or an investment property, can trigger tax complexities such as IHT and, in some cases, CGT.

If you gift property to family members but continue to live in it or retain any benefit (for example, living rent free), HMRC treats it as a ‘gift with reservation of benefit,’ meaning the property remains part of your estate for IHT purposes. Paying full market rent can remove this issue.¹

For outright gifts where no benefit is retained, the seven year rule applies. If you survive seven years after making the gift, it will usually fall outside your estate for IHT. If you die within seven years, the gift may be subject to IHT, although taper relief can reduce the tax rate (but not the value of the gift) for deaths between years three and seven.[7]

It is important to note that the Residence Nil-Rate Band (RNRB) only applies when property is passed on death to direct descendants, not to lifetime gifts. The RNRB is currently set at £175,000 and is an inheritance tax free allowance However, this allowance is tapered for estates worth more than £2 million, reducing by £1 for every £2 over the threshold.

Additionally, lifetime gifts of property (other than your main residence) may be subject to CGT at the time of the gift.

Maximising tax efficiency through strategic gifting

Regular gifting throughout your life can not only support your loved ones or charitable causes but also help manage your estate in a tax-efficient manner. However, navigating the complexities of gifting and tax law requires expertise, consulting with a financial adviser is recommended.